Saving & Investing

Making Sense of Market Curveballs

There were quite a few in 2017

As we end the year, it’s a perfect time to look back at the financial markets and examine their ups and downs. Hopefully, we can pick up a couple lessons for the future. Sure, I’ve written market forecasts are dangerous, but explaining what’s behind investment performance can be just as perilous.

South Korean stocks surge as nuclear tensions with North Korea mount

Admittedly, if I had a crystal ball and knew that North Korea would be increasing its nuclear capabilities, I may have chosen a different international strategy. I might even have ditched South Korea, which has one of the largest foreign stock exchanges in the world. Take Seoul’s proximity to the North Korean border and add global tensions over the possibility of war, and what do you get? The kind of investor anxiety that decimates confidence and shifts money toward safer places to invest.

So it’s a good thing I didn’t have that crystal ball, because I would have missed out on a more than 41 percent return (as of Dec. 22, 2017), as measured by the iShares MSCI South Korea Capped ETF (EWY). That compares to a total return of U.S. stocks of about 21 percent and international stocks overall of about 26 percent. In fact, a large part of why international stocks are besting the United States is South Korea. Had South Korean stocks faltered, surely the media would be saying it’s because of all the saber-rattling.

U.S. dollar falters as Fed raises rates

It seemed a certainty that the U.S. dollar would continue to gain against foreign currencies, as it had over the past several years. With the Federal Reserve promising three rate hikes (which it fulfilled) and some European interest rates still negative, obviously more global wealth would be parked in U.S. currency.

Unfortunately, markets don’t typically follow obvious patterns. The U.S. Dollar Index (USDX, DXY), an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies, declined by 8.75 percent (as of Dec. 22). This wiped away a large part of the gains the U.S. dollar had made over the past few years. Compared to the U.S. dollar, the Euro is up 10.4 percent, the British pound up 7.4 percent and the Japanese Yen up 3.5 percent.

Bitcoin gains 1,544%, pushing its worth to $267 billion

Bitcoin, a cryptocurrency basically created out of thin air, is today worth more than Procter and Gamble, Home Depot and Intel. In fact, only 15 companies based in the United States have a greater value than Bitcoin. The value of Bitcoin approached that of JPMorgan Chase not too long after CEO Jamie Dimon slammed Bitcoin as a fraud, saying "It's just not a real thing; eventually it will be closed." Dimon compared it to the tulip mania of 1637, when prices for bulbs reached such extraordinarily high levels that the market collapsed. Many other experts from investment companies have jumped on the bandwagon and predicted the Bitcoin bubble would burst. Yet again, while Bitcoin has been wildly volatile, markets didn’t agree.

What have we learned for 2018?

Why did South Korean stocks surge, Bitcoin erupt and the U.S. dollar falter? A Google search for any of these three curveballs will unearth a multitude of reasons why, though I’m not buying any of them. For example, one story pinned South Korea’s market success to economic growth. Sounds intuitive, but in reality, there’s no link between growth in gross domestic product and stock market performance.

Markets are unpredictable. After-the-fact explanations of shorter-term movements may be appealing but are probably just surprises in search of reasoning. Behavioral economists call this hindsight bias, a psychological phenomenon in which past events seem to be more prominent than they appeared while they were occurring.

Ultimately, this hindsight bias leads us to believe that we can use these seemingly logical explanations to predict the future, giving us newfound confidence in our foresight. And it’s those 2018 predictions that will likely be hazardous to your wealth. I can’t say it enough: Own the world with ultra-low costs and you can take advantage of most (not all) positive surprises, while a diversified portfolio will help you minimize the risk of the negative shockers.

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